Counter Culture: The old Woolworth's on First Street downtown is slated to be converted to a 1,200-seat House of Blues nightclub featuring live music acts. The San Jose Redevelopment Agency is kicking in $2.4 million for improvements to the building.

Betting On Blues

With San Jose's deal to bring House of Blues downtown, redevelopment is gambling a big subsidy in a high stakes battle between two music promotion behemoths

By Jeff Kearns

AT A SEPTEMBER press conference announcing San Jose's deal to bring the House of Blues downtown, Mayor Ron Gonzales enthused about what the deal would mean for city nightlife. "Downtown San Jose is hot," he told reporters gathered in front of the city-owned Woolworth building at 27 S. First St. that HOB plans to turn into one of the South Bay's hippest joints.

At the same time, there was plenty of the usual groaning that the San Jose Redevelopment Agency had given away the store--again--by doling out $5.7 million worth of subsidies to the club chain. Other downtown business owners griped that they'd been scraping by for years downtown and redevelopment hadn't even sent them Christmas cards, much less driven a dump truck full of cash up to their storefronts. Some even complained that the big-name club would hurt their businesses.

Redevelopment gave the usual response: It's time to bring some real muscle downtown and that's how much it costs to make things happen these days, especially if, like San Jose, you can't boast of a solid track record (the city and HOB inked a tentative deal about the same time Redevelopment Director Susan Shick was talking about demolishing the failed UA Theater, whose owners lost $10 million before moving out under cover of darkness). After all, the UA took $4 million in city money, and $10 million apparently wasn't enough for the Pavillion.

Although downtown still isn't where a lot of people would like it to be--even after one of the biggest economic expansions in the area's history, many parts of downtown still resemble a testing ground for parking lots--not many are willing to say that the HOB deal won't do the only thing it's supposed to: bring people downtown.

And while the plan has had its detractors, the mayor probably wouldn't have been standing there if the previous plan to put a Ross Dress for Less store on the site had become reality.

According to Senior VP of Development Liam Thornton, the city has already transferred the building to HOB, and the company is planning to apply for a conditional use permit as early as this week and submit its designs for the interior and exterior to the building department in July. Demolition work, which includes asbestos removal, is set to begin once the permits are issued, probably sometime in August.

The 24,000-square-foot nightclub will hold a crowd of about 1,200 and the restaurant will seat about 250. Thornton says plans may include removing part of the facade to create an outdoor courtyard.

The deal doesn't really look that bad for the city. The way it's supposed to work out is that the city pays $2.4 million for the building renovation and continues to own the property. Although HOB could pay as little as $1 a year in rent, city officials estimate that HOB will probably wind up paying about $3.3 million in rent over the life of the lease.

Under the 15-year deal, HOB pays a token $1 in rent a year if they fall short of the $8 million mark on an annual basis during the first five years. If the club grosses more (excluding tickets), rent is determined based on a percentage of gross income, and increases over time. After the first five years, rent increases according to a percentage formula, also based on gross sales.

The fine print includes an additional base rent of $15,000 per month until construction costs, plus interest, are paid off. And although the revenue threshold for determining the percentage rent is $8 million, HOB pays rent of 5 percent of gross revenues over $6 million every year.

HOB officials wouldn't say how much investment they're putting into the club, but would only say that it's a lot more than the city's share. Thornton says the club will have about 250 employees.

One of the most vocal opponents was Joel Wyrick, who owns the Waves Smokehouse and Saloon just around the corner from the HOB site. But these days he's more accepting--which may or may not be because the city gave him his own subsidy in the form of a $133,201 check to cover earthquake retrofitting costs.

"I'm dealing with it," Wyrick says. "The big picture is that it will be good for San Jose. They'll bring in a lot of top acts, and there aren't a lot of places to do that in San Jose. If we have to pay someone to bring in those acts, then so be it."

Other club owners are looking forward to the opening, which is scheduled for sometime next summer (the original opening date was supposed to be this summer, but negotiations took longer than expected). Interest is especially keen because of the void left by the closing of San Jose Live a few years back.

"It's a good thing for downtown," says club operator and concert promoter Chris Esparza, who thinks HOB will draw music fans from all over the Bay Area, along with South Bay residents. "We're the biggest city, but everyone goes somewhere else to see music, so on that level, it's going to help." However, even as he looks forward to the big-name club's opening, Esparza also says it's frustrating to see the city throw public money at a big corporation with no ties to the area. "It's a little discouraging," he says, "to have your competitors and then a large corporation coming in and not having to pay their way."

While Esparza says he's confident that HOB knows how to do it right, others, including the San Jose Business Journal, have questioned whether the club can make it even with the city's financial help. Another blues joint, JJ's Blues, couldn't make it and closed its downtown location a few years ago.

In any case, Thornton says HOB wouldn't have come to San Jose without the city's financial support. Thornton also points out that "the city was going to renovate [the building] like a typical developer would have, but they said they would give us the money they would have spent on the remodel."

Downtown Councilwoman Cindy Chavez says that while she voted to approve the deal, she still had some reservations about the size of the subsidy. "This was a risk we should take," Chavez says. "Redevelopment always plays with risk, because if there was no risk, then a private developer would do it. What we're doing is investing our public money to encourage the private sector to take hold."

Ultimately, however, the downtown club's success may depend less on San Jose than on HOB's expensive battle to compete with the 800-pound gorilla of the live music industry.

Although the company is also working on an unrelated project to build a much larger indoor concert hall at the county fairgrounds, it's still going to take considerable juice for HOB to play and win in a region and an industry dominated by a much bigger name: SFX Entertainment.

Second Fiddle

TWO YEARS AGO House of Blues shot to the number two spot among U.S. concert promoters--and hasn't budged since.

The company got its modest start in 1992 when it opened its first club on Harvard Square in Cambridge, Mass., in--what else--an old house. The newest club opened in Anaheim early this year. Other clubs are in L.A., Chicago, Orlando, New Orleans, Las Vegas and Myrtle Beach, S.C. And according to Thornton, there are more on the way. In addition to San Jose, HOB already has a lease on a spot in San Diego and has signed letters of intent in Dallas, Denver and Salt Lake City (another deal in Kansas City fell through when the developer canceled the multitenant project). Thornton says the projects are separate, so difficulties with one won't impact work on another.

But these clubs, which are mostly small venues, aren't what make HOB a national force in the concert biz.

HOB made its big move in July 1999, when it shelled out $190 million to buy Universal Concerts (plus a chunk of debt) from Universal Music Group, a division of the Canadian booze-food-media conglomerate Seagram Co. Ltd. The deal instantly made HOB a major player, with 20 concert venues in the United States and Canada, ranging in size from the 20,000-seat Coors Amphitheater in San Diego to the 1,100-seat Commodore Ballroom in Vancouver, British Columbia. In addition to venues where HOB has exclusive booking contracts, the concerts division also has promotion agreements with other venues, including one recently signed with the Flint Center in Cupertino.

But the industry's number one is by far SFX, part of broadcasting behemoth Clear Channel Communications.

The company's market dominance gives it the ability to book entire tours for megabands like U2 and 'N SYNC by promising per-show fees that sometimes exceed $1 million.

"Universal used to be number one, until SFX bought up pretty much every independent promoter in the country," says Ray Waddell, who covers the touring business for Billboard magazine. "They dominate the tour market in terms of number of tours they produce, they have dozens of amphitheaters that they own and they also have exclusive agreements."

SFX sold 21.6 million tickets in North America last year, trailed by HOB's 5.3 million. All of the industry's other players are regional. The third largest seller, Chicago's Jam Productions, sold just 1.6 million, and so far this year is on track to be bumped out of third by Metropolitan Entertainment of New York City.

SFX has also ballooned in recent years, gobbling up regional promoters across the country. Backed by corporate investors, SFX spent about $2.5 billion on a buying spree from 1997 to 2000. In addition to Bill Graham Presents, SFX also lassoed Pace Concerts in Houston, Cellar Door Concerts in Washington, D.C., Electric Factory in Philadelphia and Don Law Presents in Boston.

The most notable of these is the Bay Area's homegrown Bill Graham Presents, which is the only acquisition that SFX has allowed to keep its name.

The 1998 sale--which some purists likened to pawning off the Golden Gate Bridge--gave SFX control of several high-profile Bay Area venues, including the Fillmore, the Warfield, Concord Pavilion and 25,000-capacity Shoreline Amphitheatre in Mountain View. SFX also books the San Jose State Event Center.

SFX also expressed interest in opening a Fillmore club downtown, redevelopment officials say. But while the company did talk to redevelopment officials about the plan in late 1999, a formal proposal was never submitted.

Last year, SFX scored another one: the 1,700-seat Mountain Winery in Saratoga, which was previously operated very successfully by the nonprofit Villa Montalvo. Even though the beautiful and historic mountaintop venue was averaging a more than 90 percent sellout rate (most venues can't touch that), the owners said they decided to go for SFX/BGP when the contract with Villa Montalvo expired because it gave them more control over marketing and booking--and more money.

Gig Potential

PART OF THE REASON HOB set its sights on San Jose is the map: San Jose's music scene isn't on it.

More specifically, company officials say they wanted to get into the South Bay market because there is no 1200-seat venue, which has kept San Jose from getting shows that play the Warfield or the Fillmore. The downtown club, Thornton says, will feature rock, jazz, blues and other styles of music. It will host emerging bands and local acts, but also bigger names that have already proven themselves, like Merle Haggard, No Doubt, Everclear, Etta James or even KC and the Sunshine Band.

There are big venues, including the Compaq Center, San Jose State Event Center and, of course, Shoreline. But even with these, some promoters grumble that Santa Cruz, with the Catalyst and Palookaville, often gets bigger acts than this side of the hill and that most South Bay residents are resigned to making the trip over the hill or up to their foggy, cold neighbor to the north to catch live shows.

"To us, it's an underserved market," says Thornton. "The South Bay itself has a very strong demographic. A lot of people would come to see live music. We believe in what's happening down there and we like to think we'll be a catalyst for that."

The key to HOB's strategy is that, with its capacity of around 1,200, the San Jose club will be a midsized venue. Competitor SFX has larger venues, and the established clubs in downtown San Jose, like the Cactus Club, the Agenda, the Usual and Fuel, are mostly in the 200-300 capacity range.

Thornton says the San Jose project is the company's first where a city will be its landlord, and the first that involves direct public assistance.

"We are a bit of a pioneer there and that risk is reflected in the deal," Thornton says. "The city is being very smart about managing the risk."

Although the relationship with the city is new, Thornton says most of HOB's clubs have a similar rent arrangement, where how much it pays is determined as a percentage of gross sales.

"In order to bring in big venues like House of Blues, you have to make it attractive, and we did that," says Redevelopment spokeswoman Peggy Flynn. "This whole deal will bring back revenue to the city."

The county cut a much different deal with HOB. The county handed HOB $7.5 million as part of a 40-year contract, but HOB will be paying at least $500,000 in rent a year, plus a percentage of revenue on top of that. The county hopes to make more than $2 million a year. Work has already begun on the project and the county began receiving payments from HOB as soon as the deal closed escrow.

HOB will have an exclusive agreement on the venue, which means it gets to keep the big bucks generated by parking fees, drink sales and merchandise, making the site more profitable.

According to Senior VP of Concerts John Van Zeebroeck, the company is also shooting for an aggressive 120-130 nights a year, which would include renting the space for other events like corporate gigs and awards shows. Van Zeebroeck says the venue will probably host the kind of bigger names, such as the Dave Matthews Band, Sting and James Taylor, that play the company's Universal Amphitheater in L.A. Part of HOB's plan is to devote about a third of bookings to Hispanic acts. Van Zeebroeck says his company is the dominant promoter of Hispanic events in the United States.

But House of Blues is also facing a major hurdle: In order to remain viable long-term, it must succeed in a major expansion push. Industry insiders agree that the company is currently profitable, but facing an uncertain future.

HOB Entertainment Inc. has three divisions: clubs, concerts and interactive. Although the company is not public and is very closely held (corporate brass at both HOB and SFX would not discuss financial matters with Metro), analysts say the clubs and concerts divisions are making a profit these days. However, the interactive side, which includes web and TV production, is believed to be losing money.

And although HOB has been aggressive in its plans to expand, it can't compete with SFX on the national stage.

SFX tried to buy HOB last year, but the two parties were reportedly about $100 million apart in the negotiations and the deal fell apart (HOB wanted $450 million, but SFX was only willing to pay $350 million, industry insiders say). HOB also was one of three companies in talks last year to buy half of Metropolitan Entertainment, but that deal didn't happen either.

To raise some much-needed capital, HOB filed papers to go public last year, just four days after the market's now famous March 14 slide into oblivion. According to the filing, the company had a negative cash flow in 1996-99 and in 1999 showed a negative net worth of $102 million. However, it did show positive earnings before taxes for three of the four 6-month periods before filing.

"To date, we have not been profitable on an annual basis," the company wrote in the filing. "We incurred a net loss of $6.9 million for the six months ended December 26, 1999, approximately $8.9 million for the six months ended June 27, 1999, $10.4 million in fiscal 1998 and $18.9 million in fiscal 1997. As of December 26, 1999, we had an accumulated deficit of approximately $124 million."

When the company aborted the IPO three months later, CEO Greg Trojan cited "uncertain market conditions" in his withdrawal letter to the SEC.

An article in the May issue of Hits magazine, which tracks the music and concert industry, reported that HOB is seeking $70-$100 million in cash to build new venues and complete mergers with other promoters so that it can compete with SFX.

"We haven't been able to grow as fast as we've wanted to, and it is as frustrating to me as it probably is for others in the company," Trojan was quoted as saying. "However, we have been successful, and the company is doing well. Because of the marketplace, we've been able to do this with one, sometimes two, hands tied behind our backs. We are not just limping along." Trojan was not available for comment.

Chris Stephenson, HOB's senior VP of marketing and communications, hints that the company is about to announce some good news, although he won't provide specifics. He also says "there are a lot of misconceptions" about the company's condition.

"The majority of it is nonsense," Stephenson says. "We're working on some very interesting opportunities."

Stephenson says the company would consider another IPO if the market came back. "We're looking to grow quite aggressively, but quite frankly, we missed that window last year."

Marc Pollack, the music industry reporter who wrote the article, tells Metro that HOB's plan is to either sell out to a bigger player or form some kind of joint venture.

But that might not be so bad, says Gary Bongiovanni, executive editor of Pollstar, a tour industry trade magazine. Bongiovanni says that competition between promoters actually leads to higher ticket prices when different sides bid up how much they're willing to pay for an act. That cost, of course, gets passed on to music fans. "The impact on the average concertgoer probably wouldn't be noticeable," he says of a possible buyout.

According to Pollack's article, HOB's concerts division reportedly grosses about $250 million and nets $20 million, while the clubs side grosses around $110 million and nets $10 million. The online arm, however, has sucked up about $30 million, cutting into the money HOB needs for its expansion war chest.

That notwithstanding, the two planned HOB venues in the South Bay represent a challenge to the company's bigger competitor. Says Bongiovanni, "The Bay Area is one of only a few markets where House of Blues is actually competing head to head with SFX,"

In spite of the rumblings, HOB says it is still planning to proceed with both San Jose ventures and that the projects won't be stalled or derailed if the company changes hands.

All of this, however, doesn't necessarily mean that the company isn't good at what it does. "They're a great promoter," says Billboard's Waddell. "They have a history of going into markets away from their home base and making a pretty good footprint." Waddell adds that he doesn't see any reason why the two megapromoters can't coexist peacefully in a market.

Before entering into an agreement with the company, San Jose Redevelopment Agency officials made findings that the company was in adequate financial health.

"We would never have entered into an agreement had we not known the strength of the organization," says Deputy Executive Director Harry Mavrogenes. "The conclusion was that they're fine."